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The majority of investors seem to hate them and the rest are shorting them. While at some point shorting bonds will be a huge trade we think that the timing is still a ways off for the end of the 31-Year bond bull. So what do bonds have going for them? Well the most obvious and yet what seems to be the most overlooked is the simple trend. Looking at the chart below you should ask yourself how many times have investors been convinced that rates were too low? (click on chart below to enlarge)

30-Year Treasury Yield

Aside from the trend we have the current situation with GDP growth of only 1.7% which is very slow for a so-called recovery, especially one that is five years along. In addition we have very slow growth globally as Europe continues to blow up and we keep seeing estimates for China drop every month or two. We have very slow global growth and this is showing in very low inflation data. Yes, the central banks led by Helicopter Ben are juicing the system, hell I hear Ben is dressing up as Buzz Lightyear for Halloween so he can say “QE to infinity and beyond” but the fact is that despite their best efforts inflation remains muted.

In a world of extremely slow growth and chronically low inflation we would expect Treasuries to do well and lo and behold they have. Since QE1 was announced November 25th 2008 we have seen 30-Yr yields drop from 3.632% to 2.988% and the 10-Yr dropped from 3.092% all the way to 1.811%. If this does not make it obvious that QE alone does not cause the bond market to crash then nothing will. No, until we see stronger growth and a large pick up with inflation we expect fundamental picture to remain decent to strong for Treasuries.

Now of course we are going to get some people saying “but bonds are up too much” our natural response would be something like WTF? but our more reasoned response would be compared to what? Bonds have been up “too much” for the last 20 years. Who would have ever thought that 5% 30-Yr interest rates would sound high? Rates are low but they are a long ways from 0% which would indicate that they have room to go lower. That said what does the technical picture look for bonds? In the chart below we have our intermediate term 30-Yr Reversion to the Mean (RTM) chart. While the RTM chart isn’t saying load the boat it is also not saying run for the hills as it is instead giving us an almost perfectly neutral reading which indicates that bonds have plenty of room to go up or down before reaching anything near an oversold/overbought point. (click on chart to enlarge)

30-Yr Treasury RTM

Finally, at least for now, is the sentiment picture. We all know that volatility is one of the most mean reverting series in all of finance. In the chart below we have the Treasury MOVE index vs the 30-Yr yield and then we have overlaid the 30-Yr yield with an inverse scale. We inverted it so it is a better visual as to what happens to bond prices when the MOVE index is so low. As you can see when Treasury volatility is really low it is usually a time to be buying bonds and when it is high is when you should be selling. Well right now we are hovering close to the lows of the past five years indicating that bonds could take off at any time. (click on chart to enlarge)

So is going long bonds the new trade of the century? Nope not by a long shot. Still that doesn’t meant that there isn’t a case to be made for being long. The economic fundamentals are in place, unless you think we are the cusp of a huge growth spree. The technical picture is saying that while its not a perfect buy there is plenty of room to run. Finally sentiment/volatility are saying that the time in at hand for a renewed move higher in Treasury bonds. Obviously we could be wrong but the risk reward is there.

In the investment world it should be no surprise to anyone anymore that outlying events actually happen with a decent amount of regularity. Looking at the past 12 years we have had the Asian Contagion, Russian Default, LTCM, .Com crash, housing crash, and the subsequent crash of everything else. Most of these are one in a gazillion year type events and yet they all happened inside of 12 years. Statistics while useful, are not able to perfectly model the real world.

So mixing stats with history let us look at the MOVE Index. The MOVE Index, essentially the bond markets VIX, typically trades between 128 and 79. Anything outside of those two lines is at least one standard deviation from the mean. As you can see in the chart below we are currently more than one standard deviation below the mean and look to be headed lower. (Click on chart to enlarge)

MOVE Index

Of course the interesting thing about the MOVE Index is not what level it is at but what tends to happen when it reaches certain levels. Essentially whenever the MOVE Index drops below one standard deviation something blows up. Apparently bond market investor complacency is a better gauge of “too complacent” than other volatility gauges.

Drops below the lower one standard deviation have preceded the following events

-First Gulf War

-Asian Contagion

-LTCM bailout/Russian Default

-.Com tech crash

-Housing/Credit crisis

While it is not a crystal ball, see the extended period below one standard deviation preceding the credit crisis, the MOVE index is still a good risk gauge with a solid track record of saying investors are too risk averse or that we are too complacent and therefore not really aware of the risks on the horizon. Consider this the yellow light, its not saying stop but its not saying go either.

10-Yr Swap Spreads hit their lowest level since 1988 on 3/9/10 hitting 3.25. How many more days until they go negative? (Click on chart to enlarge)

10-Yr Swap Spread

Go short Treasuries, its the most obvious trade ever right? While they might go up or down the MOVE Index continues to forecast less and less volatility, which at least to us indicates that the market is not expecting yields to change a whole lot anytime soon. (Click on chart to enlarge)

MOVE Index

Not sure if Chanos is right on China being in a huge bubble, but looking at the chart it appears as though at least a few investors are less than bullish. (Click on chart to enlarge)

FXI China ETF

We just crossed the one year anniversary of the current rally/bull market the other day. Over that time on a weekly closing basis the SP500 is up over 66%. This has been the largest one year rally in over 60 years. We are starting to hedge our long exposure as we are currently cautiously bullish. (Click on chart to enlarge)

SP500 1-Yr Rolling Returns

Back in December we shorted the Euro on the basis of the EU being weak, overvalued, and sentiment becoming far too one sided. In these pages we also looked at buying the USD on a technical basis. Looking at the USD and T-Bills however shows another reason for the USD rally. (Click on chart to enlarge)

We keep hearing that long term Treasury Bonds are going to tank and that we need to get short before they fall off a cliff. While this may very well happen, we doubt that it occurs anytime soon. We are not alone in this view as Bill Gross and the gang at PIMCO seem to agree. While some argue with his view of a new slow growth period the market does not seem to have an issue with it. Not only has Helicopter Ben said that the Fed is not raising rates anytime soon, but market indicators are saying the same thing.

One Treasury indicator that we use is the MOVE index which is a “yield curve weighted index of the normalized implied volatility on 1-month Treasury options. It is the weighted average of volatilities on the CT2, CT5, CT10, and CT30.” As you can see in the chart below it has been falling since July as the market has come to the realization that we are in for a slow growth period and that the Fed is not going to raise rates any time soon.

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Title: Interest Rates and the MOVE Index
URL: http://www.themacrotrader.com/2009/11/18/interest-rates-move-index/